AD-AS Analysis from the Perspective of Functional Finance Theory and MMT

Research background

In the past few years, MMT (Modern Money Theory or Modern Monetary Theory) has been increasingly discussed in Japan as well as in the U.S. However, both in the U.S. and Japan, analysis using mathematics is lacking and analysis using IS-LM and AD-AS analysis methods in macroeconomics is almost non-existent.

Purpose

We present an AD-AS analysis from the perspective of Functional Finance Theory and MMT (Modern Monetary Theory).

Research methodology

Graphical analyses with some mathematical analyses. Mathematical analyses include graphic analysis using AD and AS curves and calculations to derive equations representing them based on models of consumer and firm behavior.

Results

Using an overlapping generations model under monopolistic competition we show the following results by calculations and graphical analyses.

1. The budget deficit (including interest payments on government bonds) equals an increase in the savings of consumers from period to period. This result means that the debt-GDP ratio would not diverge to infinity, but would remain at a finite value whether the interest rate of government bonds is larger or smaller than the growth rate.

2. We need a budget deficit (including interest payments) to maintain full employment without inflation under economic growth. However, if the interest rate of government bonds is larger than the growth rate, we need a budget surplus (excluding interest payments) to maintain full employment without inflation.

3. A return to full employment from a recession can be achieved by implementing the appropriate fiscal policies through increased government spending or tax cuts.

4. Excessive government expenditure or an insufficient tax under full employment induces inflation.

Novelty

This is probably the first AD-AS analysis done from the standpoint of Functional Finance Theory and MMT.